Budget Analysis

Budget Analysis – 2011-12

Highlights
• Fiscal deficit pegged at 4.6% of GDP for 2011-12.

• Fiscal deficit projected at 4.1% and 3.5% for 2012-13 and 2013-14, respectively.

• Revenue deficit for 2011-12 pegged at 3.4%.

• Revenue deficit for 2010-11 revised downwards to 3.4% from the budgeted estimate of 4.0%.

• Net market borrowings for 2011-12 is budgeted at Rs. 3,430 billion, 2.3% over 2010-11.

• Total expenditure for 2011-12 to increase by 3.4% over 2010-11.

• 1.4% fall in capital expenditure, while 4.1% increase in revenue expenditure over 2010-11.

• Personal income tax slabs changed:

o Income upto Rs.1.8 lakhs – nil.
o Income between Rs. 1.8 lakhs and Rs. 5 lakhs – 10%.
o Income between Rs. 5 lakhs and Rs. 8 lakhs – 20%.
o Income above Rs. 8 lakhs – 30%.
o Incomes of senior citizens between 60 and 80 years of age, to be exempted upto Rs.
2.5 lakhs and for those above 80 years, exemption applicable upto Rs. 5 lakhs.

• Standard rate of excise duty on all non-petroleum products to be maintained at 10%.

• Minimum Alternate Tax (MAT) rate to be increased from 18% to 18.5%.

• Rate of service tax retained at 10%, but coverage extended.

• Disinvestment receipts for 2011-12 estimated at Rs 40,000 cr.

• Government to move towards direct transfer of cash subsidy for kerosene and fertilizers.

• Foreign investors who meet Know Your Customers (KYC) norms to be allowed to invest in
Indian equity mutual funds.

• FII limit for investment in corporate bond with residual maturity of over five years issued by
companies in infrastructure sector, is raised by US$ 20 billion to US$ 25 billion

• Rs 6,000 cr allotted to public sector banks to maintain a Tier 1 CRAR of 8% during 2011-12

• Direct Tax Code to be implemented by April 1, 2012

• Allocation to infrastructure at Rs. 2,14,000 cr for 2011-12, 23.2% higher over previous year
Budget Analysis

Overview

The three key macroeconomic concerns before the Union Budget 2011-12 were high inflation, high
current account deficit (CAD), and fiscal consolidation. Additionally, there was an expectation that the
government would restart the reform process. The Budget has made an attempt to address all these
issues, albeit through small steps. Despite the strong performance of the economy in 2010-11, the
outlook for 2011-12 is clouded by stubborn and persistently high inflation, and rising external risks.
While the Budget sets a lower nominal gross domestic product (GDP) growth target of 14%, we believe
that the real GDP growth target of 9% factored in the Budget is on the optimistic side. We expect GDP
growth to moderate to 8.3% in 2011-12.
By lowering the fiscal deficit target to 4.6% in 2011-12 from 5.1% achieved in 2010-11, the Budget
reiterates its commitment towards medium-term fiscal consolidation. The absence of rollback of
stimulus (excise) was a bit of a disappointment, though, given that economic growth has recovered. As
the Budget sets a lower deficit and net borrowing target, it is not expansionary, and does not conflict
with the Reserve Bank of India’s measures to tame inflation, at least in intent. The issue is how
realistic the target is. We believe that the fiscal deficit will settle around 5% of GDP in 2011-12 – a
slippage of 40 bps – as we expect lower growth, lower tax buoyancy, and absence of one-off gains.
There are further risks of slippages on subsidy expenditure – on oil and fertilisers, the Budget
estimates are conservative. Some bold steps towards expenditure reforms were missing, and will have
to be initiated through the year to keep a lid on the subsidy bill and maintain the fiscal space for
increased spending on physical and social infrastructure.
On the infrastructure front, like in the previous Budget, physical infrastructure has been accorded
prime importance. An allocation of Rs 2,14,000 cr has been provided for infrastructural development
in 2011-12, which is 23.3% higher than in 2010-11 and amounts to 48.5% of the gross budgetary
support to Plan expenditure.
To remove the funding constraints for the infrastructure sector, the disbursement target of the
government-established India Infrastructure Finance Company Limited (IIFCL) will be raised by Rs
5,000 cr to Rs 25,000 cr by March 31, 2012, along with issuance of tax free bonds worth Rs 30,000 cr
by various government undertakings. In addition, the FII limit for investment in corporate bonds with
residual maturity of over five years issued by infrastructure companies has been raised by an
additional US$20 billion, taking the limit to US$25 billion. In order to facilitate the funding of rural
infrastructure, the corpus of the Rural Infrastructure Fund (RIDF) was raised by Rs 2,000 cr to Rs
18,000 cr for 2011-12.
Social sector spending too remains one of the top priorities of the government. However, refraining
from announcing new schemes, the Budget has laid stress on providing reasonable allocation to the
existing schemes, in order to curb fiscal deficit and provide room for the committed Right to Food Act.
An allocation of Rs 1,91,400 cr has been provided to social services and rural development in Budget
2011-12. However, y-o-y growth of total budget support, together with internal and extra budgetary
resources (IEBR), stands at 7.8% in 2011-12 as compared to 27.4% in 2010-11.
On the inclusiveness front, the Budget has inflation-indexed its flagship MGNREGA scheme to ensure
stability in real wages. Its usefulness could have been multiplied if the scheme had been dovetailed
with activities that create durable infrastructure and raise productivity in agriculture. Moreover,
improved monitoring of the scheme to check leakages would have made these programmes more
credible and effective.
Budget Analysis

Equity Market

Although Budget 2011-12 has not rolled back the stimulus for the markets, it is low on significant
policy actions. Hence, we believe it is essentially neutral for the domestic equity markets. The markets
are expected to cheer the lower-than-expected fiscal deficit target of 4.6% and an effective revenue
deficit of 1.8% for FY12. However, we expect 4.6% to be challenging – based on GDP growth estimate
of 8.3% for 2011-12 – which is less than the government’s target of 8.75-9.25% growth.
Increased capital outlay and other policy measures for infrastructure, education and realty sectors are
expected to boost sentiments and support players’ growth, but the overall impact on profitability may
not be significant. The allocation to infrastructure has been raised by 23.3% to Rs 2.14 lakh cr. The
FII limit for investment in corporate bonds (with maturity over five years) issued in the infrastructure
sector has been raised by US$20 bn. Further, the additional deduction of Rs 20,000 for investment in
long-term infrastructure bonds would be extended in FY12. While these measures will facilitate
financing of infrastructure projects, we believe execution delays rather than financing pose a bigger
challenge for infra companies. The budget allocation for education too has been increased by 24%,
which includes Rs 21,000 crore under Sarva Shiksha Abhiyan. The liberalisation of interest
subvention of 1% on housing loans and enhancement of housing loan limit to Rs 25 lakh for units
under priority sector lending would be positive for players in affordable and low income housing.
On the taxation front, increase in exemption limits - resulting in uniform tax relief of Rs 2,000 - would
be positive for consumer discretionary items. On the one hand, reduction in surcharge from 7.5% to
5% is positive for corporates; on the other, increase in MAT rate from 18% to 18.5% is negative.
Further, the Direct Taxes Code (DTC) is expected to be rolled out as scheduled and the Goods and
Services Tax (GST) Amendment Bill will be introduced in this parliament session.
Continuing with its divestment agenda, the government has set a target of raising Rs 40,000 crore
through divestment of its stake in central public sector undertakings. However, volatile market
conditions could put a spoke in the government’s divestment wheel.
We believe that allowing foreign investors to invest in the domestic market through the mutual fund
route is a key positive, and will increase funds flow from foreign investors. It would prove to be a shot
in the arm for the domestic mutual fund industry in the long run.
We expect FY12 to be a tale of two halves for the Indian market. In the first half, we expect the market
to remain subdued due to concerns over high commodity prices, inflation and earnings downgrade,
whereas in the second half we expect a potential absence or a bare minimum impact of most of these
factors to provide buoyancy to the markets. Expectation of strong GDP growth coupled with attractive
valuation would support the market in the second half. In the light of global concerns and earnings
downgrade, we have tempered our expectations of returns. We expect the Nifty to trade at 6200-6400
(Sensex 20700-21200) by the year-end (December 31). We expect banking, IT and pharmaceuticals to
deliver strong returns but we remain neutral on telecom and infrastructure, and negative on real
estate.
 Budget Analysis

Sector Analysis

Auto components & Tyres - Budget to have neutral impact

The Union Budget 2011-12 is not likely to have any significant impact on the Indian auto components and
tyres industry. The exemption on customs duty on spare batteries for electric vehicles (cars and two-
wheelers) and concessional excise duty of 4% on these batteries will reduce the maintenance cost of these
vehicles. However, this is not expected to have any significant impact on demand for auto components,
given the low population of electric vehicles in India. Natural rubber (NR) will attract customs duty of 20%
or Rs 20 per kg (whichever is lower), with effect from April 2011. This will not have any significant impact
on the landed cost of NR at current price levels.
Automobiles - Budget to have no significant impact on automobile industry

The Union Budget 2011-12 is not likely to have any significant impact on the Indian automobile industry.
The extension and enhancement of interest subvention on crop loans from 2 to 3%, revision of wage rates
under the NREGA scheme and continued focus on rural development will have a marginally positive
impact on rural two-wheeler and tractor sales. The extension of tax slabs for individual tax payers from Rs
1.6 lakh to Rs 1.8 lakh will aid two-wheeler sales. The overall impact on passenger cars and commercial
vehicles segment will be largely neutral. The launch of a ‘National Mission for Hybrid and Electric
Vehicles’ and various excise and customs duty benefits proposed for hybrid, electric, fuel cell and
hydrogen cell technology-based vehicles or their parts is unlikely to have any immediate impact, though it
will aid alternate fuel vehicle sales over the longer term.
Banking and Finance - Rise in priority sector home loan limit to benefit banks

As per the Union Budget 2011-12, housing loan limit under priority sector would be enhanced from Rs 20
lakhs to Rs 25 lakhs. Also, the limit for interest rate subvention of 1% on home loans would be increased
from Rs 10 lakhs to Rs 15 lakhs, for houses priced below Rs 25 lakhs. These measures are expected to
assist banks in accomplishing their priority sector lending targets and lower lending rates for borrowers.
The hike in interest rate subvention for agriculture loans from 2 to 3% and increased target for credit flow
to farmers would facilitate availability of funds at cheaper rates.
Public sector banks will be provided Rs 6,000 cr in 2011-12 (in addition to the Rs 23,200 cr provided in
the last 3 years) to maintain a minimum tier-I capital adequacy ratio of 8%, thus improving their ability to
pursue loan growth more aggressively.
Cement - Increase in excise duty negative

The Union Budget 2011-12 has proposed the replacement of existing excise duty rates with a 10% ad
valorem rate and an additional Rs 160 per tonne of cement. This results in an effective 2-4% increase in
the excise duty for the cement industry. In the current operating environment, cement players will not be
able to pass on the increase in duty to customers. Further, the Union Budget has proposed a reduction in
custom duties for gypsum and pet coke from 5% to 2.5%. Gypsum accounts for a mere 2-3% of the total
cost of sales for cement players. Moreover, pet coke is used as raw material by a select few companies
only. Hence, the reduction in custom duties is insignificant for the cement industry.

Construction - FII limit on corporate infrastructure bonds raised; tax-free bonds permitted
An increase in the foreign institutional investment (FII) limit by US$20 billion for investment in corporate
infrastructure bonds will help mop up bond issues. Further, select government undertakings like Indian
Railway Finance Corporation have been allowed to issue tax-free bonds totalling Rs 300 billion. Also, the
allocation for Bharat Nirman has been increased by 20% in 2011-12. IIFCL’s loan disbursal target has
been set higher as well at Rs 25,000 cr for 2011-12 from an estimated Rs 20,000 cr in 2010-11. The
additional tax exemption of Rs 20,000, provided in 2010-11, on investment in long-term infrastructure
bonds has been extended to 2011-12. These proposals are expected to address the funding needs of the
infrastructure segment, and could lead to a faster take-off of infrastructure projects. However, these may
not push up the bottomlines of construction companies. Hence, we believe that the impact of the budget
on the construction sector is neutral.
 Budget Analysis

Housing - Increased focus on affordable housing

The interest rate subvention of 1% has been extended for housing loans up to Rs 15 lakhs (for houses
costing less than Rs 25 lakhs) from Rs 10 lakhs earlier (for houses costing less than Rs 20 lakhs).
Further, priority sector lending limit for housing loans provided by banks has been enhanced from Rs 20
lakhs to Rs 25 lakhs. The rural housing fund has been enhanced to Rs 3,000 cr from Rs 2,000 cr while
HUDCO has been allowed the issue of tax free bonds up to Rs 5,000 cr. These measures will provide a
boost to affordable housing. The budget has also proposed investment linked tax deduction for affordable
housing projects. This will lead to higher investments in affordable housing projects.
Note: The proposal to levy 18.5% minimum alternate tax (MAT) on developers of special economic zone will
have a negative impact on real estate companies with a SEZ focus. This could negate the positive impact
of the residential segment thus, making the impact neutral for the overall real estate segment.

Information Technology - MAT levy on SEZ and non-extension of STPI benefits to impact player
profitability
The proposal to bring SEZ units under the purview of the Minimum Alternative Tax (MAT) and the non-
extension of tax benefits for STPI units is expected to adversely impact the profitability of IT players. Mid-
sized players would be more affected as a larger proportion of their revenues accrue from STPI units vis-à-
vis tier-I players. MAT has been raised from 18% to 18.5%, whereas surcharge has been reduced from
7.5% to 5%, keeping the effective MAT rate at the same level.
Domestic IT services, which constitute about 20% of the IT services revenues, are expected to get a shot in
the arm from the planned government expenditures aimed at improving IT infrastructure and delivery
mechanisms.

Oil and Gas - No major impact on oil & gas sector

The Union Budget (2011-12) will have no major impact on the oil & gas sector. However, the government
has indicated that it would gradually move towards direct transfer of cash subsidies on LPG and kerosene
to people living below the poverty line. This will reduce under-recoveries for oil marketing companies in
the future. The government has provided for Rs 23,700 cr as its share in under-recoveries for 2011-12.
This is significantly lower than the revised estimates of Rs 38,600 cr for 2010-11. However, we believe that
if under-recoveries increase significantly, the government will increase its contribution towards the same.

Pharmaceuticals - Neutral impact of the budget on the Pharmaceutical sector

The impact of the Union Budget 2011-12 on the Pharmaceuticals industry is neutral. The increase in
excise duty on formulations from 4% to 5% will have negligible impact on the industry.

Telecom - Neutral impact on telecom services sector

The government has marginally increased the Minimum Alternate Tax (MAT) from 18% to 18.5%. At the
same time, it has reduced the surcharge levied from 7.5% to 5%. The cut in the surcharge rate neutralizes
the impact of the increase in MAT by keeping the effective rate of MAT unchanged. The exemption from
basic, countervailing duty (CVD) and special additional duty (SAD) on components and accessories of
mobile handsets has been extended for the next financial year and a few more items have now been
included in its ambit. The extension of duty exemptions would help in sustaining the current low prices of
mobile handsets.

Textiles - Mandatory excise on branded garments negative for textiles

The impact of the Union Budget 2011-12 is negative for the textiles sector. A mandatory excise duty of
10% is being imposed on branded readymade garments (RMG) and textile made-ups. Since it is under
Cenvat Credit, yarn and fabric manufacturers may have to pay an increased excise duty at 5% vis-à-vis an
optional and concessional 4% duty paid earlier. This will exert further pressure on the margins of RMG
and made-ups manufacturers who are already struggling with an unprecedented rise in input costs.
However, the reduction in customs duty on Acrylonitrile and rayon grade wood pulp, from 5% to 2.5%
each, will benefit acrylic and viscose fibre manufacturers respectively by reducing their raw material costs.
As a result, the cost competitiveness of viscose and acrylic will improve vis-à-vis cotton and polyester.
Higher budgetary allocation under Technology Upgradation Fund Scheme (TUFS) to Rs 2,980 cr from Rs
2,270 cr is a positive for the sector.
 Budget Analysis

Mutual Funds and Financial Market

Budgetary measures and their impact

1. Foreign individual investors allowed to invest in mutual funds

To liberalise the portfolio investment route, the government has decided to permit SEBI registered mutual
funds to accept subscriptions from foreign investors who meet the KYC requirements for equity schemes.
Currently, only FIIs and sub-accounts registered with the SEBI and NRIs are allowed to invest in mutual
fund schemes.
Impact

This will widen the investor base of mutual funds and give non-SEBI registered foreign investors an
opportunity to invest in Indian equity markets. The measure would also provide an avenue to boost equity
mutual fund AUM. More technology enabled products with enhanced risk management practices are
expected to be launched for the global audience.

2. Increase in Dividend Distribution Tax (DDT) for money market and debt funds

DDT increased to 30% from 25% on investments made by firms into money market and debt funds. For
retail investors it stays unchanged at 12%.
Impact

This would place corporate plans of debt and money market funds at par with bank fixed deposits and thus
may impact inflows.

3. Increase in FII limit in corporate bonds

To enhance the flow of funds to the infrastructure sector, the FII limit for investment in corporate bonds,
with residual maturity of over five years issued by companies in the infrastructure sector, is being raised
by an additional limit of US$20 billion; this takes the limit to US$25 billion. This will raise the total limit
available to FIIs for investment in corporate bonds to US$40 billion. FIIs would also be permitted to invest
in unlisted bonds with a minimum lock-in period of 3 years and will be allowed to trade amongst
themselves during the lock-in period.

Impact

Although an increase in the FII limit is a positive factor, the corporate bond market is expected to remain
range bound as the appetite for investment in infrastructure bonds by FIIs, which till now was US $5 billion,
has not been utilized to its fullest. Moreover, since infrastructure as a segment does not account for a major
share of issuances in the corporate bond market in India, the impact of the above measure is not expected to
be significant in the movement of corporate bond yields.
4. Increase in allocation towards infrastructure bonds

• For 2011-12, an allocation of over Rs.2,14,000 crore is being made for the infrastructure sector –
a y-o-y growth of 23.3%.
• In order to give a boost to infrastructure development in railways, ports, housing and highways
development, the government proposes to allow tax free bonds of Rs.30,000 crore to be issued by
various government undertakings in the year 2011-12. This includes Indian Railway Finance
Corporation (Rs 10,000 crore), National Highway Authority of India (Rs 10,000 crore), HUDCO (Rs
5,000 crore) and Ports (Rs 5,000 crore).

Impact

The continued thrust on infrastructure funding is expected to result in an increasing appetite for
infrastructure-oriented mutual funds. The focus on infrastructure projects is likely to result in an increasing
number of corporate bond and equity issuances for fund raising by infrastructure companies and
institutions. This would provide an expanding avenue for mutual funds to invest in. It would also boost the
 Budget Analysis

investment avenues for major market participants such as insurance companies and PF trusts enabling
them to utilize their investment limit in ‘additional category’ as defined in their investment guidelines in
these bonds.

5. Set-up of notified infrastructure bonds

To attract foreign funds for infrastructure financing, the government proposes to create Special Vehicles in
the form of notified infrastructure debt funds. The income of these funds would be exempt from tax.

Impact

The above measure could lead to fund flow from private equity players and major overseas hedge fund. The
added tax incentives could lead to an increase in allocation of their investments into the emerging market
debt through these funds.

6. Life Insurance Companies come under service tax net

Services provided by life insurance companies in the area of investment are proposed to be brought into
the tax net on the same lines as ULIPs.

Impact

This may have a negative impact on the bottom line of the insurance companies. The incremental impact can
be more on insurance companies with a larger share of non-ULIP products.

7. Penetration of “Swavalamban”

The co-contributory pension scheme called “Swavalamban” announced in the previous budget has
received over 4 lakh applications from workers in the unorganised sector. Based on feedback, the
government proposes to relax the exit norms whereby a subscriber under Swavalamban will be allowed to
exit at the age of 50 years instead of 60 years, or a minimum tenure of 20 years, whichever is later.
Further, it is proposed to extend the benefit of government contribution from three to five years for all
subscribers of Swavalamban who enroll during 2010-11 and 2011-12. An estimated 20 lakh beneficiaries
are expected to join the scheme by March 2012.

Impact

The proposal to prepone the exit age as well as government contribution being extended to five years from
three years would help increase penetration levels in the PFRDA initiative.

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